Hearing It Out

Estate Planning

The law is complicated. It is intimidating to small businesses, ranchers, and farmers. The law lacks certainty for the American people. We seriously need estate tax reform.-Statement of Max Baucus Regarding Alternatives to the Current Federal Estate Tax.1

The Senate Finance Committee has held a series of hearings on the federal estate tax. The 3/12/08 hearing examined alternatives to the present transfer tax system. Three professors discussed alternative wealth transfer tax systems focusing primarily on a change to an accessions tax. The 4/3/08 hearing featured two lawyers and a CPA from private practice, along with an executive from a tax-exempt organization, all of whom addressed ways to reform the existing estate tax system.

The Finance Committee is taking a timely and refreshing look at tax policy in the transfer tax area. The ten-year journey on which we set off with the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") is nearly complete. If Congress wishes to avoid the nonsensical one-year repeal in 2010 followed by the reappearance of pre-2001law in 2011, action must be taken in 2009. The testimony at the Senate Finance Committee hearings illuminates the various paths that Congress could follow.

Alternatives to the Estate Tax

Three professors presented alternative systems for taxing wealth at the 3/12/08 hearing. Some clarification of terminology is required for this discussion. Typically, the difference between an estate tax and an inheritance tax is that an estate tax applies one rate schedule, often with a series of progressive rates, to the value of the taxable estate and imposes that tax on the estate itself. By contrast, an inheritance tax generally is imposed on the heirs, with a tax computed on the property received by each heir. The rate schedule may vary depending on the relationship between the decedent and the heir. Usually, the rate applicable to any particular heir is flat. Most European countries impose an inheritance tax rather than an estate tax at death.

Those are not the only options, however. Some have suggested that the taxation of wealth transfers be married with the income tax. If Section 102 of the Code were repealed, the receipt of a gift or bequest would be taxable income to the recipient. Professor Joseph Dodge referred to this system as an "income inclusion approach."2 The income inclusion approach looks at each tax year on a freestanding basis, without regard to whether the taxpayer has received gifts or bequests in any prior year.

A modified version of an income inclusion approach is an accessions tax. Under an accessions tax, the tax would be imposed on the recipient of a gift or bequest, but there would be a cumulative exemption for each recipient (as opposed to each donor), effectively allowing every person to receive a certain amount of gifts or bequests without tax. As proposed by Professor Lily Batchelder, receipts ofwealth transfers in excess of the exempt amount would be taxed at income tax rates, with a surtax on cumulative receipts over a certain amount.3

Thus, an accessions tax is similar to an inheritance tax in that it taxes the recipient, and it is similar to an estate tax in its ability to provide an exemption and a somewhat graduated rate schedule. Like an income inclusion approach, the tax could be self-assessed on the income tax return. Depending on the amount of the cumulative exemption and the level at which the surtax applies, an accessions tax could be designed to generate as much revenue as the present estate tax, but its burden would fall on a slightly different set of taxpayers. According to Professor Batchelder, under the present estate tax, 30% of heirs inheriting between $2.5 million and $5 million are not burdened by the estate tax at all, while 4% of those inheriting between $500,000 and $1 million are burdened by the estate tax.4 An accessions tax would level the playing field for heirs.

The accessions tax is favored by the academics in large part because it aligns the imposition of the tax with the actual burden of the tax. Philosophically, it is easier to refute the double taxation argument with an accessions tax. Opponents of the estate tax argue that imposition of an estate tax amounts to double taxation of income on which the taxpayer has already paid income tax. By imposing the tax directly on the heirs, it becomes clear that a tax at death is not a second tax on the decedent's money, but a tax on the recipient's windfall.

Furthermore, one of the primary justifications for having an estate tax is to prevent the accumulation of vast amounts of wealth in the hands of a few. By focusing on the taxable estate in the hands of the decedent, however, the estate tax fails to take into account the decedent's own plan for redistributing his or her wealth. The accessions tax offers an incentive to "spread the wealth" among a greater number of heirs, and provides a financial disincentive for leaving one's wealth to a small number of heirs.

Professor David Duff articulated the public relations problem very clearly: "The gift and estate tax sends exactly the wrong message about a wealth transfer tax by taxing successful, hardworking and generous donors who have accumulated wealth out of income on which they have often paid tax already. In contrast, an accessions tax sends a very different and justifiable message by taxing the beneficiaries of substantial gifts and inheritances on amounts that they have not themselves earned and on which they have not themselves paid any tax."5

In addition to the philosophical support, an accessions tax offers neat solutions to some problems under the estate tax, eliminating the need for some complex estate planning. For example, the proceeds of life insurance would be taxed to the person who receives the proceeds, eliminating the need to know who holds the "incidents of ownership."6 Such a change would also eliminate the need for dividing assets between husband and wife, since the exemption amount would relate to the heir and not the decedent. Lastly, because the accessions tax would mostly likely be reported on a schedule to the income tax return, the whole infrastructure of the estate and gift tax filings could be eliminated.

Assuming that states followed the shift to an accessions tax, there could be a dramatic shift in which states collect taxes at death. Unlike aging retirees, who disproportionally relocate to warmer climates, heirs are not as free to relocate to avoid taxes on the deaths of their parents and others. Consequently, accessions tax payers are more likely to be disbursed among the 50 states. The change to an accessions tax at the state level would be a revenue enhancer for some states and a revenue loser for others.

A change to an accessions tax could have an adverse impact on charity. A decedent could have the same impact on the overall tax bill at death by leaving a bequest to a person who has not used his cumulative exemption amount as would be the case if the same bequest were left to charity. Given this option, an individual may choose to leave funds to more remote relatives instead of to charity.

Professor Batchelder estimates that an accessions tax would be revenue neutral compared to present law for the year 2009 if each heir had a cumulative lifetime exemption of $1. 9 million and inheritances (or gifts) in excess of that amount were subject to income tax at the heir's rates plus a 15% surtax. Alternatively, the lifetime cumulative exemption could be $1.6 million, with the excess taxed at the applicable income tax rate plus a 10% surtax.

In the final analysis, a switch to an accessions tax has considerable philosophical appeal, but the practical burdens of the change would be great. Were we starting from scratch, there are clear advantages to the accessions tax. The professors seem to favor an accessions tax primarily because it accords more easily with the actual burden of the estate tax (on the heirs). However, the accessions tax does not shift the actual burden of the tax. Ifthe issue is one of public perception, perhaps education about the true impact of the estate tax would work just as well without having to revamp the entire wealth transfer tax system.

Options for Reform

Dennis Belcher, an attorney in private practice, focused his testimony on ways to modernize Section 6166.7 Section 6166 should apply regardless of the choice of business entity; thus, the law needs to be clarified to specifically include modern business entities such as limited liability companies, limited partnerships, and business trusts. Mr. Belcher also identified the holding company provisions as provisions in need of modernization, as they are so complex that a highly specialized (and expensive) attorney is needed to guide a client through them.

Another burdensome requirement ofSection 6166 is the lien procedure. The lien provisions should be enforced in a standardized fashion and in a manner that doesn't interfere with the business's ability to continue to operate. Mr. Belcher and the other panelists confirmed under questioning that the five-year deferral is a critical aspect of 6166, and that the ten annual payments provide adequate time to raise funds for the estate tax payments.

The second topic discussed at the hearing was portability of the unified credit and GST exemption. Shirley Kovar's portability proposals8 was warmly received by the Finance Committee members. Portability, the idea that any unused portion of a deceased person's unified credit would be made available to his or her surviving spouse, was presented as a simple proposal that avoids unnecessary complicated estate planning and accords with what spouses would really want to do with their assets, absent tax considerations.

Accordingly, if a married couple has assets of $2 million each, the standard estate planning recommendation under present law would be to establish a bypass or credit shelter trust upon the death of the first spouse in order not to waste his or her unified credit. While the tax savings makes it relatively easy to convince clients to provide for bypass trusts, left to their own devices, most of these clients (at least those in first marriages) would bequeath the property outright to the surviving spouse. Portability would allow them to satisfy both goals, leaving the property outright to the surviving spouse without sacrificing the first spouse's unified credit. It would also eliminate the need for complex estate planning.

While the primary focus of the portability discussion has been on the estate tax, the same arguments justify portability of the GST exemption. Inclusion of the GST exemption would simplify planning for those who intend to make gifts to grandchildren or others. It would also fit in with the philosophy of portability.

The only possible objection to portability is its revenue cost, which was not mentioned at the hearing. Because a significant number ofpeople fail to do the planning necessary to use both spouses' unified credits, enabling people to do so through portability is estimated to cause revenue loss. If the portability provision is to be revenue neutral, the combined unified credit would have to be less than double the individual unified credit amount.

The third proposal, presented at the hearing by CPA and Professor Roby Sawyers, was to reunify the estate and gift tax.9 Specifically, since the enactment of EGTRRA, the exemption level for the estate tax and the GST exemption amount has increased several times, while the exemption level for the gift tax has been stationary at $1 million. As Professor Sawyers pointed out, the disunification of the gift tax and the estate tax provides perverse incentives. It creates a disincentive to business succession planning during life, since assets passed by gift will trigger a gift tax while those same assets held until death could pass free of estate tax. It also discourages intrafamily transfers in general. Reunification of the estate and gift tax would promote simplicity by avoiding the complex planning that can be used to avoid lifetime gifts.

Ostensibly, the gift tax exemption was left at $1 million to protect the income tax base after the repeal of the estate tax. Since it seems very unlikely that the estate tax will be repealed, that justification for the disunification does not support the continued disjunction of the two exemption levels. Because common planning techniques avoid the payment of gift tax and delay intrafamily transfers, it is unlikely that the increase in the gift tax exemption to the estate tax exemption level would even have much revenue impact.

The final witness, Diana Aviv, expressed support for the estate tax because of its positive impact on charitable giving.10 Late in the hearing, this comment drew some criticism from the Senators, who opined that charitable giving should not be coerced.

Ms. Aviv spoke to changes that would encourage compliance with the estate tax laws and improve the IRS's ability to find and stop charitable giving abuses. Specifically, Ms. Aviv asked for full funding of the IRS audit function. Second, she encouraged electronic filing as a way to reduce the manpower needed to review tax returns for errors. Finally, she described as abusive the use of the actuarial tables to establish the value of the charitable deduction and taxable gift subject to gift tax at the inception of a charitable lead trust. Ms. Aviv asked for assistance in preventing that abuse and others where taxpayers get larger deductions than the amount that eventually flows to charity, or the noncharitable beneficiaries ultimately get amounts greatly in excess of the actuarial value of the gift when the trust was established.


The specific proposals for reunification of the unified credit, portability, and modernization of Section 6166 are all practical and would greatly simplify the estate tax for many taxpayers. They would address congressional concerns regarding complexity and taxpayers' needs for sophisticated estate planning. These proposals have been vetted and refined over the years. Congress would be welladvised to enact them when it is addressing the wealth tax system next year.

More global reform or replacement of the estate tax is probably too ambitious to address in the short time frame before 2010. However, the Finance Committee should be commended for taking a serious look at tax policy in the wealth tax area this year. The hearings were a refreshing change from the usual discussion of whether to repeal the estate tax, and if not, what should the rates and exemption levels be. Continued thoughtful debate of these issues will be a long-term benefit to the wealth tax system.

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice. 

BETH SHAPIRO KAUFMAN, of the District of Columbia and Maryland Bars, is a partner in the Washington, D.C. office of the law firm of Caplin & Drysdale, Chartered. She is aiso a Fellow of the American College of Trust and Estate Counsel, and has written and lectured extensively on estate planning.


1. Hearing Statement of Senator Max Baucus (0Mont.) Regarding Alternatives to the Current Federal Estate Tax System, available at www.senate.gov/~finance/hearings/ statements/031208mb. pdf

2. See Testimony of Joseph M. Dodge before the Committee On Finance, U.S, Senate, 3/12/08, available at www.senate.gov/~finance/hearings/testimony/2008tesV031208jdtest.pdf

3. See Testimony of Lily L. Batchelder before the Committee on Finance, U.S Senate, 3/12/08, available at www.senate.gov/~finance/ hearings/testimony/2008tesV031208Ibtest.pdf

4. See Testimony of Lily L. Batchelder before the Committee on Finance, U.S Senate, 3/12/08, available at www.senate.gov/~finance/ hearings/testimony/2008tesV031208Ibtest.pdf

5. See Testimony of David G. Duff before the Committee On Finance, U.S. Senate, 3/12/08, available at www.senate.gov/~finance/ hearings/testimony/2008test/031208dd test.pdf

6. See Testimony of Joseph M. Dodge, supra note. 2.

7. Testimony of Dennis I. Belcher before the Committee on Finance, U.S Senate, 4/3/08, available at www.senate.gov/~finance/hearings/ testimony/2008tesl/040308dbtest.pdf

8. Testimony of Shirley L. Kovar before the Committee on Finance, U.S Senate, 4/3/08, available at www.senate.gov/~finance/hearings/testimony/2008tesl/040308sktest.pdf

9. Testimony of Roby B. Sawyers before the Committee on Finance, U.S Senate, 4/3/08,  available at www.senate.gov/~finance/hearings/testimony/2008test/040308rstest.pdf

10. Testimony of Diana Aviv before the Committee on Finance, U.S Senate, 4/3/08, available at www.senate.gov/~finance/hearings/testimony/2008tesl/040308datest. pdf

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